By Nelson DeMestre | Associate Analyst at NAOS Asset Management
“Time plays a particularly important role for investment decisions. The payoffs to a firm’s investment made today accrue as a stream over the future”.
Investment Under Uncertainty, written by two Economist Professors, Avinash Dixit and Robert Pindyck, can aid anyone looking for a clear explanation on several key issues faced by investors. It provides a catalogue of explanations on almost every facet of capital allocation, including investment timing, option pricing, depreciation, exit strategies, dealing with industry dynamics (Oligopolies etc), valuing risk adjusted returns, sunk costs and pricing. It expands upon the theories we may know the periphery of through formulas and case studies.
One of the essential facts noted by Dixit and Pindyck is the often unexpected and tragic results investors are occasionally granted when entering a booming industry:
“With industry-wide uncertainty, each firm knows that others will enter or expand in response to favourable developments just as it does. The resulting increase in supply will dampen the price increase, thereby reducing the firm’s upside profit potential, and therefore the value of its own investment”.
This provides a warning to firms and investors that are confident that a boom in certain industries, commodities or products etc, cannot help but provide attractive returns. In such scenarios, Dixit and Pindyck caution that uncertainty makes waiting more valuable and discourages immediate investment.
Link to book
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